The Role of Capital in Financial Institutions

This paper examines the role of capital in financial institutions. As the introductory article to a conference on the role of capital management in banking and insurance, it describes the authors' views of why capital is important, how market-generated capital requirements' differ from regulatory requirements and the form that regulatory requirements should take. It also examines the historical trends in bank capital, problems in measuring capital and some possible unintended consequences of capital requirements. According to the authors, the point of departure for all modern research on capital structure is the Modigliani-Miller (M&M, 1958) proposition that in a frictionless world of full information and complete markets, a firm s capital structure cannot affect its value. The authors suggest however, that financial institutions lack any plausible rationale in the frictionless world of M&M. Most of the past research on financial institutions has begun with a set of assumed imperfections, such as taxes, costs of financial distress, transactions costs, asymmetric information and regulation. Miller argues (1995) that these imperfections may not be important enough to overturn the M&M Proposition. Most of the other papers presented at this conference on capital take the view that the deviations from M&M s frictionless world are important, so that financial institutions may be able to enhance their market values by taking on an optimal amount of leverage. The authors highlight these positions in this article. The authors next examine why markets require' financial institutions to hold capital. They define this capital requirement' as the capital ratio that maximizes the value of the bank in the absence of regulatory capital requirements and all the regulatory mechanisms that are used to enforce them, but in the presence of the rest of the regulatory structure that protects the safety and soundness of banks. While the requirement differs for each bank, it is the ratio toward which each bank would tend to move in the long run in the absence of regulatory capital requirements. The authors then introduce imperfections into the frictionless world of M&M taxes and the costs of financial distress, transactions costs and asymmetric information problems and the regulatory safety net. The authors analysis suggests that departures from the frictionless M&M world may help explain market capital requirements for banks. Tax considerations tend to reduce market capital requirements , the expected costs of financial distress tend to raise these requirements , and transactions costs and asymmetric information problems may either increase or reduce the capital held in equilibrium. The federal safety net shields bank creditors from the full consequences of bank risk taking and thus tends to reduce market capital requirements . The paper then summarizes the historical evolution of bank capital ratios in the United States and the reasons regulators require financial institutions to hold capital. They suggest that regulatory capital requirements are blunt standards that respond only minimally to perceived differences in risk rather than the continuous prices and quantity limits set by uninsured creditors in response to changing perceptions of the risk of individual banks. The authors suggest an ideal system for setting capital standards but agree that it would be prohibitively expensive, if not impossible. Regulators lack precise estimates of social costs and benefits to tailor a capital requirement for each bank, and they cannot easily revise the requirements continuously as conditions change. The authors continue with suggestions for measuring regulatory capital more effectively. They suggest that a simple risk-based capital ratio is a relatively blunt tool for controlling bank risk-taking. The capital in the numerator may not always control bank moral hazard incentive; it is difficult to measure, and its measured value may be subject to manipulation by gains trading . The risk exposure in the denominator is also difficult to measure, corresponds only weakly to actual risk and may be subject to significant manipulation. These imprecisions worsen the social tradeoff between the externalities from bank failures and the quantity of bank intermediation. To keep bank risk to a tolerable level, capital standards must be higher on average than they otherwise would be if the capital ratios could be set more precisely, raising bank costs and reducing the amount of intermediation in the economy in the long run. Since actual capital standards are, at best, an approximation to the ideal, the authors argue that it should not be surprising that they may have had some unintended effects. They examine two unintended effects on bank portfolio risk or credit allocative inefficiencies. These two are the explosive growth of securitization and the so-called credit crunch by U.S. banks in the early 1990s. The authors show that capital requirements may give incentives for some banks to increase their risks of failure. Inaccuracies in setting capital requirements distort relative prices and may create allocative inefficiencies that divert financial resources from their most productive uses. During the 1980s, capital requirements may have created artificial incentives for banks to take off-balance sheet risk, and changes in capital requirements in the 1990s may have contributed to a credit crunch.

The effect of market size structure on competition: the case of small business lending

Banking industry consolidation has raised concern about the supply of small business credit since large banks generally invest lower proportions of their assets in small business loans. However, we find that the likelihood that a small business borrows from a bank of a given size is roughly proportional to the local market presence of banks of that size, although there are exceptions. Moreover, small business loan interest rates depend more on the size structure of the market than on the size of the bank providing the credit, with markets dominated by large banks generally charging lower prices.Small business ; Bank size ; Bank loans ; Banking market

Parasites on parasites:Coupled fluctuations in stacked contact processes

We present a model for host-parasite dynamics which incorporates both vertical and horizontal transmission as well as spatial structure. Our model consists of stacked contact processes (CP), where the dynamics of the host is a simple CP on a lattice while the dynamics of the parasite is a secondary CP which sits on top of the host-occupied sites. In the simplest case, where infection does not incur any cost, we uncover a novel effect: a non-monotonic dependence of parasite prevalence on host turnover. Inspired by natural examples of hyperparasitism, we extend our model to multiple levels of parasites and identify a transition between the maintenance of a finite and infinite number of levels, which we conjecture is connected to a roughening transition in models of surface growth

Sustaining Collection Value: Managing Collection/Item Metadata Relationships

Many aspects of managing collection/item metadata relationships are critical to sustaining collection value over time. Metadata at the collection-level not only provides context for finding, understanding, and using the items in the collection, but is often essential to the particular research and scholarly activities the collection is designed to support. Contemporary retrieval systems, which search across collections, usually ignore collection level metadata. Alternative approaches, informed by collection-level information, will require an understanding of the various kinds of relationships that can obtain between collection-level and item-level metadata. This paper outlines the problem and describes a project that is developing a logic-based framework for classifying collection-level/item-level metadata relationships. This framework will support (i) metadata specification developers defining metadata elements, (ii) metadata librarians describing objects, and (iii) system designers implementing systems that help users take advantage of collection-level metadata.Institute for Museum and Libary Services (Grant #LG06070020)published or submitted for publicationis peer reviewe

Some challenges facing logistics education at the new millennium

Although the future of logistics looks bright as the new millennium approaches, logistics programs in higher education face significant changes and challenges. This article examines six challenges—three challenges facing business education in general and three challenges directly and uniquely facing logistics education. Five propositions about the future of logistics education are developed. For logistics education, particularly the traditional logistics programs, the years after the new millennium will be both the best of times and the worst of times

Volunteerism among hospitalists and non-hospitalists at academic and community medical centers in North Carolina

Volunteerism is common in the United States, though less is known about volunteerism among medical professionals. We aimed to record and compare volunteer activities among hospitalists and non-hospitalists in academic and community centers.Includes bibliographical reference

A critical analysis of universal design for learning in the U.S. federal education law

Universal Design for Learning (UDL) has been frequently discussed as a framework that guides the design of inclusive learning environments for all students with and without disabilities. This policy brief reports on findings of a content analysis of how UDL was referenced in three major U.S. federal education laws. Results indicate that UDL was not explicitly defined although it was closely tied to alternative assessment and technology in K-12 education laws. References to UDL in the higher education law suggested using UDL to guide inclusive educational practices for post-secondary students and the need to integrate the framework into educator preparation